Markets last week
After seven down weeks, risk markets finally recovered last week. Equities staged a meaningful rally globally, with the exception of emerging markets. The movement was probably a technical bounce, since nothing fundamental improved in economic data and the minutes from the US Federal Reserve (Fed) did not signal any reprieve in the relentless pace of rate hikes.
The UK was the focus of attention, as the services Purchasing Managers’ Index (PMI) collapsed, weighing on sterling for a couple of days, and as the Chancellor of the Exchequer finally decided to slap a windfall profits tax on oil and gas companies to help British households with their energy bills.
Economic data was not earth-shattering last week. In the US, there was a noticeable slowdown in housing, but steady employment and income against the backdrop of softer economic surveys. Surprisingly, German data seemed to indicate a rebound in activity. China was still under scrutiny by world investors, with industrial profits tumbling but the authorities trying to revive the weak economy through monetary and fiscal policy, which helped trigger a rebound in Chinese technology shares.
After a few weeks of softness recently, oil prices strengthened during the week in line with the recovery in investment sentiment rather than tighter supplies or headlines from the conflict. At the end of the week, Brent crude neared US$120/bbl, near the high that followed the onset of the Ukraine war.
Over the week, equities sported a large bounce. Government bond yields were fairly steady with US yields falling but Europe and the UK rising, and the US yield curve spread (difference between 2-year and 10-year treasury bonds) at 26 bps. The US dollar fell quite sharply with risk appetite returning. It has now given up more than 1/3 of its advance since the beginning of the Ukraine conflict.
Within equities, technology was the recovery poster child, up 7.5% in US dollars, whilst defensive sectors improved less. Quite logically then, the US market was the strongest whereas Asian and emerging markets struggled to make any progress.
The week ahead
Monday: China manufacturing and non-manufacturing PMIs and Caixin manufacturing PMI.
Our thoughts: the Chinese PMIs have collapsed in the last few months, mostly due to the COVID-19 infection lockdowns in light of the zero COVID-19 policy and poor efficiency of the Chinese vaccines. There is a market expectation of a recovery, in particular in the non-manufacturing PMI which collapsed to the low 40s the previous month. Markets have started to price in a recovery in Chinese activity after the additional stimulus offered by the authorities. How much of that improvement will be visible in the PMIs? The relative performance of Chinese and far eastern equities compared to the rest of the world, may well be affected by the Chinese PMIs.
Wednesday: US ISM manufacturing PMI + JOLTS job openings.
Our thoughts: the Fed wants to slow the US economy to tackle inflation, hoping that this will create a soft landing rather than a recession. The jury is obviously still out as to whether the Fed will be able to accomplish this feat of moderate slowdown. Some data may be able to help us understand whether we are likely to get there or not. The Institute for Supply Management (ISM) is one of them. The ISM manufacturing PMI paints a very detailed picture of the US industrial sectors: orders, backlogs, exports and imports, delivery times, employment, inventories, etc. The regional Fed surveys (New York, Philadelphia, Kansas City and Richmond) overall have shown a steep drop this month, hence there is now the expectation that the ISM manufacturing survey will also fall meaningfully. Markets will undoubtedly react to the findings. Separately, the Job Openings and Labor Turnover Survey (JOLTS) has been the subject of endless amazement recently, with more than 1.7 jobs openings per jobseeker, so it will be interesting to see whether there is a softer tone to the data.
Friday: US employment numbers.
Our thoughts: of all the areas in the US economy that the Fed wants to slow down, the jobs market must be the most difficult. Employment doesn’t move up and down like a yo-yo, it either grows or shrinks non-stop. The trends don’t normally revert until there is a recession afoot. The current expectation for May employment data is for a 100K reduction in the non-farm payroll increase, whilst the unemployment rate should keep falling with the labour force participation rate steadily improving. This will obviously not please the Fed, who would like to see a change in the job creation trend. It will also be important to note the movement in average hourly earnings. Pre-COVID-19 earnings were rising at a 3.5% annualised and the recent reading was almost 5.5%. Are we likely to revert back to pre COVID-19 earnings growth or stay permanently at higher levels?
The numbers for the week
Sources: FTSE, Canaccord Genuity Wealth Management
Central banks/fiscal policy
Will UK Chancellor help to households make a difference?
There were no surprises in the minutes of the May meeting of the Fed. The Fed sees the need to continue raising rates by 50bps for the next few meetings, but then “many participants judged that expediting the removal of policy accommodation would leave the Committee well positioned later this year to assess the effects of policy firming and the extent to which economic developments warranted policy adjustments.” They were also pleased that their comments had helped shift “market expectations regarding the policy outlook into better alignment with the Committee’s assessment and had contributed to the tightening of financial conditions.”
The British government announced the imposition of a 25% windfall tax on the profits of oil and gas companies, raising about £5bn to provide payments of £650 to more than eight million of the poorest households in the UK. Around eight million pensioners will receive payments of £300 while energy bills will also be subsidised by £400 for every household in the UK, replacing a previous plan for £200 loans. The package is worth £15bn overall.
Mixed but softer surveys and falling housing activity point to a slowdown whilst inflation eases.
Surveys: the Chicago Fed National Activity Index improved from 0.36 to 0.47, albeit below estimates. The Richmond Fed manufacturing index slumped from +14 to -9 and the Kansas City Fed Manufacturing Activity Index eased from 25 to 23, still a good reading. The PMIs were softer too, with the S&P Global Manufacturing PMI down from 59.2 to 57.5 and the services PMI down from 55.6 to 53.5. The final University of Michigan sentiment index was downgraded from 59.1 to 58.4, mostly coming from expectations.
Employment: initial jobless claims eased somewhat from 218K the prior week to 210K, whereas continuing claims picked up from 1315K to 1346K.
Inflation: the Personal Consumption Expenditures (PCE) deflator fell from 6.6% to 6.3% in April, although this was still above estimates. The PCE core deflator (which is used by the Fed as its inflation gauge) fell from 5.2% to 4.9% in line with expectations. The final University of Michigan 1-year inflation expectation was 0.1% lower at 5.3% vs. 5.4%.
Housing: new home sales collapsed 16.6% in April to a level not seen since the early COVID-19 lockdowns in 2020. Pending home sales fell 3.9% in April for an 11.5% year-on-year drop.
Industry: durable goods orders rose 0.4% in April or 0.3% ex. transportation. Capital goods orders non-defence ex aircraft rose 0.3%, down from 1.1% the previous month.
Trade: the trade balance (deficit) narrowed sharply in April, falling from US$125.9bn to US$105.9bn, as the US economy slows and companies reduce stockpiling. Retail inventories rose 0.7% in April, down from 3.0% the prior month and wholesale inventories eased from 2.7% to 2.1%.
Income and spending: personal income was slightly softer, at 0.4% in April vs. 0.5% previously, and personal spending fell from 1.4% to 0.9%.
Services activity slump not reflected in retail surveys (yet?)
Public finances: the April public sector borrowing requirement increased from £13.9bn to £17.8bn, in line with estimates.
Surveys: the S&P Global/CIPS Manufacturing PMI fell from 55.8 to 54.6, but the services PMI collapsed from 58.9 to 51.8. The CBI retailing surveys were stronger, with the retailing reported sales up from -35 to -1 and the total distribution reported sales from +3 to +13.
Are German surveys bottoming?
Surveys: PMIs were softer, with the S&P Global Eurozone Manufacturing PMI falling from 55.5 to 54.1 and the services PMI from 57.7 to 56.3. The IFO Business Climate Survey in Germany improved from 91.9 to 93.0, mostly due to the current assessment up from 97.3 to 99.5 whereas the expectations were almost unchanged at 86.9 vs. 86.8. Also in Germany, the GfK Consumer Confidence Barometer was very similar, at -26.0 vs. -26.6, very close to the historical low.
Money supply: eurozone M3 money supply fell from 6.3% year-on-year to 6.0% in April.
Major drop in Chinese industrial profits but Japan a smidge better.
China: industrial profits in April fell 8.5% year-on-year.
Japan: the Jibun Bank Services PMI improved from 50.7 to 51.7, bucking the trend of other regional PMIs across the world. The manufacturing PMI was a little softer, at 53.2 vs. 53.5.
The Producer Price Index (PPI) for services increased from 1.3% to 1.7%.
Without much in the way of news to trigger the move, oil prices rose sharply last week, approaching the psychological US$120/bbl level for Brent. In the US, crude and gasoline stockpiles continued to fall as the US driving season starts.